Does setting cash-rental rates feel a little like playing roulette? Can you guess the winning number? Surging farmland values and volatile crop and input prices are complicating next year’s cash-rent decisions – and intensifying risk.
Many wonder if future revenue will be high enough to justify escalating rent? Meanwhile, costs for seed, fertilizer, fuel and chemicals are going up. Beyond that, who can predict next year’s weather or yields?
All in all, “It’s very hard to know ahead of time what rent will be fair,” says Purdue University Ag Economist Craig Dobbins.
One way to cut some of the guesswork is with a flexible cash lease. Unlike fixed cash rent, flex rent adjusts automatically as crop yields or prices fluctuate.
“I look at flexible rent as a hedge on risk,” says Arvid Schwartz, who raises corn, soybeans, sweet corn and winter wheat in Sibley County, MN. He has nearly 20 years of experience with flexible leases. “In a good year, you’ll pay more rent – but in a good year you don’t mind paying more rent. In a poor year you’ll pay less rent.” And it’s those poor years “that we worry about.”
Schwartz, who served as chief financial officer and treasurer of Twin Cities-based Group Health Plan (now Health Partners) before going into production agriculture, has farmed for 23 years. He has the financial strength to withstand a drop in farm markets. But, “if I were a young farmer, renting most of my land, I’d want to have flexible cash-rent agreements. You can really appreciate what that would mean in a poor year.”
There are many ways to structure flexible leases, Purdue’s Dobbins says. Rents can adjust for yield, price or total revenue. “I recommend the total revenue approach, which adjusts for both price and yield.”
In the simplest revenue-sharing lease, the landowner receives a portion of the gross crop revenue. In Iowa, for example, rent has historically ranged from 30% to 45% of the crop value, says Jim Jensen, Iowa State University (ISU) farm business management specialist. In the last five years, though, Iowa rents have not risen as fast as crop values, he says.
Dobbins agrees: “In general, revenue from crop production has outpaced rents.”
Another common flexible lease calls for a base or guaranteed minimum rent, plus a potential bonus. If total revenue exceeds a specified threshold, the landowner gets a share of the additional money. If revenue falls short of the bonus threshold, the tenant pays only the base rent, which is usually less than the local going rate.
Flexible leases require landowners and tenants to agree on:
• a base or minimum rent and, if desired, a maximum rent;
• the amount of revenue needed to trigger a bonus rent payment;
• how to calculate yields and crop prices; and
• how to divide up bonus revenue.
Flexible leases are more complex than fixed cash leases and take more time to negotiate, says Loyd Brown, president of Hertz Farm Management, Nevada, IA, which manages 2,000 farms in central Indiana, Illinois, Iowa, Nebraska, southern Minnesota and eastern Colorado. In the last five years, about half of the company’s cash-rental properties have switched to revenue-sharing flexible leases. These agreements are a very fair way to go in today’s volatile farm economy and competitive rental markets, Brown says. “Both owners and operators are interested in long-term relationships and being fair with each other.”
Setting up a flex cash-rent lease
Here are some suggestions on how to set up a flexible cash-rent lease.
* Negotiate the base rent. If this is the minimum rental payment, it should be 10-15% lower than typical cash rent for comparable land, so the owner shares some downside risk, ISU’s Jensen says.
Just as in a fixed cash-rent contract, Jensen adds, the base rent on a flex contract will be affected by land quality, Corn Suitability Rating, yield history, drainage, location and fertility levels. You could consider setting the base rent at the amount that was paid for the land a few years ago, he says.
The lower the base rent, Jensen notes, the sooner the bonus should kick in. Likewise, the closer the base rent is to the market rate, the more crop revenue is needed to trigger a bonus payment, he says.
Along with a minimum rent, consider setting a maximum rent, too, suggests Minnesota farmer Arvid Schwartz. That protects both parties from excessive risk, helps the farmer with budgeting and crop-insurance decisions, and creates a strong incentive for the farmer “to do a really first-class job of management to get those extra bushels.”
Corn & Soybean Digestcolumnist and farm management analyst Kent Thiesse notes that maximum rental rates are typically $50-100 above the base rent.
The lease should specify payment dates for base rent and any bonus due.
* Set the base revenue.The basis for revenue sharing is each tenant’s actual cost of production, says Hertz Farm Management’s Loyd Brown. That includes inputs, crop insurance and base rent, as well as returns to labor, machinery and risk. How revenue above the base amount gets divided up “is something we negotiate with each operator, based on all the other lease factors.” The formula is based on corn, although operators are free to plant soybeans, Brown adds.
You can also use your state’s estimated cost of crop production to set the revenue base, Jensen says. The landowner would typically receive about 30% of earnings above the base revenue as a bonus rent payment for corn, and about 40% for soybeans.
* Establish the crop price. Some ofHertz Farm Management’s flexible leases call for averaging cash bids for December delivery at a nearby elevator on the first trading days of March, June, August and October. Others use the average closing price on the first trading day of the month from January through October for December corn and November soybean contracts on the CBOT futures market.
You could also average your local FSA posted county prices for several set dates, Jensen says. Average new-crop cash bids for at least three or four periods, he advises. Avoid calculating crop value using only the price at harvesttime, he says, because “then the tenant can’t sell crop ahead with confidence.”
* Determine actual yields. Jensen suggests using federal crop-insurance yields, which the tenant turns in for the year of the lease.Other acceptable ways to determine actual yield include GPS yield maps, weigh wagons, elevator scale tickets or bin measurements, Brown says. Yield numbers should be adjusted to a specified moisture level.
* Run some scenarios. It’s very important to test your flexible-lease formula by plugging in different prices and yields to get a sense of the range of possible rents, Dobbins says. “You need to spend some time with a spreadsheet, asking a lot of ‘what ifs.’” Include an example of the formula in your written lease, too, he adds.
Iowa State University has an interactive online tool to help you analyze flexible leases: www.extension.iastate.edu/agdm/wholefarm/xls/c2-21flexiblerentanalysis.xls
* Make it clear. Sample flexible-lease agreements are available from most state Extension offices.Also, keep in mind that flexible leases “require increased communication with landowners about what’s going on,” Dobbins says. He advises informing landowners about crop progress and price trends during the season.
Farmer and landowner share risks
For nearly 20 years, south-central Minnesota farmer Arvid Schwartz rented a farm on a flexible-lease basis. Schwartz farms about 2,200 acres near Green Isle with two younger partners.
His flexible lease called for a base rent, which was lower than the market rate. If yields exceeded a specified level, the landowner received a bonus payment, which was a percentage of the base rent. For example, if yields were 25% above the threshold, the bonus would equal 25% of the base rent. The rent was capped to keep it within a desirable range, Schwartz adds.
In years with very good yields, “the landowner came out better than the highest rents in the neighborhood,” Schwartz says. “But in a short crop year, like 1993, all we paid was the base rent,” while growers with fixed leases “had to pay quite a bit more.” As with a fixed cash-rent lease, though, Schwartz bore all the price risk. “We still had to be smart with our marketing.”
Two-thirds of the base rent was due in the spring and one-third in the fall, with the final settlement after harvest. Schwartz always provided the landowner with a detailed spreadsheet and copies of the elevator scale tickets, so “he knew exactly what we were doing.”
Owner and tenant negotiated the base rent and cap each year. “He’d come with an idea, and we’d come with a proposal, and we were usually reasonably close.”
The flexible lease kept the landowner involved in production agriculture – something he greatly enjoyed. This year, because of his advancing age, they switched to a fixed cash lease. “But the greatest testimony to the success of our flexible lease is that we farmed that way for nearly 20 years,” Schwartz says.